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Guide to budget analysis

budget analysis we mean the set of necessary elaborations and evaluations to be able to understand the economic, patrimonial and financial profile of an economic subject (company, firm, local unit, etc.) of which the accounting data of one or more periods are known.

To carry out a budget analysis it is necessary:
identify the data source (balance sheet, chart of accounts, interim financial statements, ..);
study its structure (ordinary, abbreviated, consolidated statutory financial statements, charts of accounts valued extracted from management (Zucchetti, Teamsystem, Sistemi, SAP...), Financial statements extracted internal systems (bank systems, ERP,) AQR extension 1, Cost of Sales, processed in excel, financial statements of foreign subjects;
define for which accounting periods to carry out the analysis and the duration of each period (eg Annual, quarterly, monthly, etc.);
define what the Reclassification scheme is destination that you intend to adopt on the basis of your needs (Added Value and Contribution Margin, Sources-Use, Liquidity, AQR extension 1, OIC, IAS/ IFRS, etc.);
reclassify the items of the source to reorganize the data in a way that allows and facilitates its interpretation.

Although the destination reclassification schemes are many and sometimes very different from each other, it is preferable to identify a pattern that is commonly recognized and shared with one's interlocutors.

The reclassification operation therefore allows for standardize data regardless of source, or to bring any data source back to a standard scheme.

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The use of a standard scheme regardless of the source, allows you to:

  1. facilitate the interpretation of the results;
  2. compare the results with those of other analyzes even if elaborated from different sources;
  3. check for errors;
  4. save time.

The more information from the source, the better and more in-depth the resulting analysis will be. The reclassification scheme must always be linked to the data from the source that generated it so that the user can always link the synthetic data to the original data.

Sources

Generally when one thinks of the analysis of the financial statements, reference is made to the statutory financial statements that Italian joint-stock companies are obliged to deposit annually. The statutory financial statements (Abbreviated, Ordinary, Consolidated, ..) it is filed annually and refers to an annual year of twelve months (although as known there are numerous exceptions).

The balance sheet analysis, however, can be carried out using any accounting prospectus as a source, the structure of which can follow very different logics.
In general, for an accounting statement it is correct to consider any data source that has the following elements:

  1. a registry (name, address, identification code (eg VAT number / tax code, Company Tax Code, ..);
  2. a list of accounting items not necessarily organized according to the classic Group, Master, Sub-Account structure, etc .;
  3. accounting periods (es. 31/12/2015, 31/03/2015(3)…):
  4. for each accounting period, the values ​​corresponding to the individual items.

Within this definition of data source it is clear that a large number of cases can fall, of which the set of subsequent financial statements are only a subset, namely:

  • financial statements and accounting situations extracts from management systems;
  • processed in excel;
  • financial statements in foreign languages ​​of foreign subjects;
  • any other source that meets the criteria listed above;
  • financial statements and accounting situations reclassified into standard formats (Eg. AQR extension 1, OIC, IAS/ IFRS, ...).

Why are the financial statements reclassified?

The reclassification of the financial statements is necessary whenever it is necessary to interpret, through accounting data, the economic, equity and financial profile of a company or a group of companies and to understand their management performance or hypothesize their future performance. Sometimes the reclassification of the financial statements is also necessary for feed IT procedures that require rigid input schemes. Just think of some procedures in the banking sector or external accounting are to give some examples.

there different reclassification schemes each of which allows to highlight specific aspects; isolate the items relating to the characteristic management, highlight the sources of the uses, highlight the degree of liquidity, etc). Whatever the scheme adopted, the reclassification should allow for bring the original accounting data back to a single scheme known to the analyst thus allowing both better interpretability and comparison with other subjects.

Reclassification although it can be supported by automatic reclassification systems such as Leanus®, often imposes choices that only the analyst is able to make correctly, sometimes only by having access to information confidential to the company. Just think, for example, of the division of costs between fixed and variable, of the distinction between characteristic and non-characteristic revenues, or of the identification of the IVA of Customer Credits.

The items in the financial statements whose reclassification will be highlighted in the sheet it can be done in a different way and the relative effects deriving from the different choices. In this sheet, using the statutory financial statements of an Italian company as a data source, the reclassification of the income statement to Value Added and Contribution Margin and the Balance Sheet by Sources and Use and by Liquidity is described. It also describes how to process the Cash Flow Statement with the Indirect Method and finally how to calculate the main indices.

The reclassification of the statutory financial statements

As anticipated in the introduction, to reclassify a balance sheet or an accounting statement it is necessary to define the standard reclassification model to be adopted. There are several reclassification schemes. The following models widely used by professionals are described below.

  • Income Statement (Classic) - Value Added and Costs by Nature
  • Income Statement (Management) - Added Value and Contribution Margin
  • Balance Sheet Source-Uses
  • Balance Sheet for Liquidity

Once the reclassification of the Income Statement and the Balance Sheet has been obtained, the following can also be processed:

  • The Cash Flow Statement with the so-called "indirect method"
  • The balance sheet indices (Profitability, Solidity, Efficiency, ...)
  • Additional indicators (Break-even, Financial leverage, Operating leverage, ..
  • The creditworthiness assessment scores
  • The incremental debt capacity and the credit line
  • ...

Below, first for the Income Statement and to follow for it Balance Sheet both the reclassification schedules and the list of items in the statutory financial statements associated with each item of the destination schedule are reported.

The reclassification of the statutory financial statements - Income Statement (Classic)

The reclassification of the income statement is generally easier than that of the balance sheet items. Despite this it is necessary to consider some elements:

  • the structure of the scheme destination and the purposes it intends to achieve;
  • the sign with which the costs are represented (some schemes in fact report the costs in absolute value, others with a minus sign).

The (classic) Income Statement represented in the figure below has the objective of isolate the result of the Characteristic Management, or all items of revenues and costs deriving from the pursuit of the corporate purpose. Viewing the image allows you to identify:

  • il Value added, or the difference between the revenues from core business and Consumption;
  • EBITDA or MOL, or the difference between the Added Value and all the costs deriving from the Characteristic Management (Personnel, Services, Use of Third Party Assets) - indicates the ability of the company to generate operating margins before depreciation, amortization and write-downs;
  • EBIT or MON, that is the difference between EBITDA and Depreciation, Provisions and Write-downs.

The following items allow you to manage all the additional items with respect to the characteristic management:

  • Miscellaneous operating revenues / charges
  • Financial Management
  • Extraordinary Management
  • Taxes

The reclassified value-added income statement represents the method most used in practice and the most suitable for an analyst outside the company; in fact, this method of reclassification it does not require additional information compared to those obtainable from the financial statements nor does it require hypotheses relating to the subdivision of costs between fixed and variable ones. The model allows you to focus on the operating cycle, taking into account the factors that the company uses to carry out its management activities, i.e. Raw Materials, Costs for Services, Cost for the Use of Third Party Goods and Costs for Personnel and to obtain the main levels of margins.

Below is the reclassification of the statutory financial statements in the (classic) income statement model.

The levels of margins are influenced by the reclassification criteria adopted.

The main elements that can cause variations, sometimes very significant, are listed below.

  • Reclassification of item A5 - Other revenues: If it is believed that such revenues should not be included in the core business, then they should be reclassified under item 4.4 - Balance of other operating expenses / revenues. The standard Leanus reclassification scheme provides that only item A1. Revenues from sales and services is reclassified under Revenues. Item A5. Other Revenues, on the other hand, are reclassified under Other Operating Revenues.
  • Reclassification of costs for services, personnel and use of third party assets. Part of these balances may have to be included in item 4.4 - Balance of other operating expenses / revenues.

Regardless of the reclassification criteria adopted, the Net Income of the reclassified format ARE NOT it may differ from the Source's Net Income.

The reclassification of the statutory financial statements - Income Statement (Management)

The operating income statement or to value added and contribution margin differs from the previous one in that allows you to distinguish operating costs between "Fixed" and "Variable" and then to determine the Contribution margin given by the difference between the Added Value and the Variable Costs. The determination of the Contribution Margin, allows you to understand for each level of Revenue what are the resources that can be used to cover fixed costs and all other commitments related to management.

Determination of the Contribution Margin it is also extremely important why allows you to calculate the "Break-Even" values, or the level of revenues that must be achieved to cover the total operating costs (technically, the value of revenues that makes EBIT null and void). The determination of fixed costs and sometimes variable it may not be easy especially if you do not have adequate information on cost behavior.

The levels of margins are influenced by the reclassification criteria adopted.

The main elements that can cause variations, sometimes very significant, are listed below.

  • Reclassification of item A5 - Other revenues. If it is believed that such revenues should not be included in the core business, then they should be reclassified under item 4.4 - Balance of other operating expenses / revenues. The standard Leanus reclassification scheme provides that only item A1. Revenues from sales and services is reclassified under Revenues. Item A5. Other Revenues, on the other hand, are reclassified under Other Operating Revenues.
  • Reclassification of costs for services, personnel and use of third party assets. Part of these balances may have to be included in item 4.4 - Balance of other operating expenses / revenues.

Regardless of the reclassification criteria adopted, the Net Income of the reclassified format ARE NOT it may differ from the Source's Net Income.

The Balance Sheet Sources - Lending

From a purely accounting point of view, the Balance Sheet, pursuant to article 2424 of the civil code, looks like a document with opposing sections, in which the assets owned by the company are highlighted on the one hand, and its liabilities and shareholders' equity on the other. However, this representation defined by the Legislator is not fully effective for the purposes of evaluating the economic, equity and financial profile of the company from the management point of view. With this representation, in fact, it is not possible to highlight the value of the characteristic working capital, of the net invested capital (Net Equity + Pfn) and of the same Net financial position (Financial payables - Liquidity).

As with the Income Statement, there are numerous balance sheet reclassification schemes each of which responds to different information needs. The scheme generally adopted for the evaluation of companies is the so-called "Sources-Uses" whose main purposes are:

  • isolate sources of financial resources (Liquidity, Payables to Banks and Equity) from the investments of these resources in the Medium-Long Term (Net Fixed Assets) and in the Characteristic and ARE NOT ;
  • calculate the Net Invested Capital (see diagram below) important for the purpose of determining the return on investment (ROI);
  • to isolate the Characteristic Working capital (Trade receivables, inventories, trade payables);
  • evaluate the coherence between sources (Eg Net Equity) and Investments (eg Net Fixed Assets).

Log in to Leanus.it to view both the summary scheme and the detailed balance sheet scheme.

It should be remembered that the source scheme uses the following characteristics:

  • the value of the Net Fixed Assets (Tangible, Intangible and Financial Fixed Assets net of the Depreciation Fund) is identical to that reported in the statutory financial statements
  • the value of Trade Payables, Other Payables, Funds and Cash they must be represented with the sign "-"
  • the Funds they are reclassified with the sign "-" among loans
  • The Net Equity it is identical to that reported in the statutory financial statements
  • Available liquidity it is reclassified with the sign “-” among the Sources.

The results of the analyzes are influenced by the reclassification criteria adopted.

The following are the main elements that can cause variations, sometimes very significant:

  • valorisation of trade receivables / trade payables;
  • valorisation of Financial Debts (e.g. inclusion or non-inclusion of debts to other lenders in Pfn).

Regardless of the reclassification criteria adopted:

  • the Net Equity of the Reclassified scheme ARE NOT it may differ from that of the statutory financial statements;
  • the total SOURCES it cannot differ from the total APPLICATIONS.

To complete the reclassification scheme it is necessary to know the distribution of Total Debts and Total Credits in the respective sub-items (Customer Receivables, Other Receivables, Supplier Payables, Financial Payables, Other Payables); this information is generally not available for abbreviated financial statements.

The Balance Sheet for Liquidity

A second classic method of reclassification of the balance sheet is the one that follows the Liquidity-Collectability criterion. In fact, the scheme first shows the items that can be readily liquidated, then those that can be liquidated in the short-medium term and finally the fixed ones.
The criterion used therefore for this reclassification is the temporal one, both sides of the balance sheet are represented according to increasing collectability: on the one hand, we go from Immediate liquidity (item more liquid and payable than the short term) to Fixed assets (less liquid item and collectible only against capital losses in the medium-long term); on the other, we proceed from Current liabilities (Financial and non-financial) to the Net Equity.

The points of attention highlighted for the “Sources-Employment” balance sheet also apply the “liquidity” scheme.

The Cash Flow Statement

The Cash Flow Statement, regulated by art. 2425 ter of the civil code, its objective is to represent the amount, composition and change in cash and cash equivalents during the reference year. The change in cash and cash equivalents generates the so-called Financial Flows (also known as Cash Flows) which are divided into three different categories: Operating Activity, Investment Activity and Financing Activity (including assets to and from Shareholders).

The analysis of the financial statements cannot disregard the evaluation of the cash flows nor from understanding what they originate from (in the case of inflows) and how they are used. The calculation of these flows can take place according to two criteria, the Direct one (CE and SP are analyzed item by item, calculating the impact of each on cash and cash equivalents) or the Indirect one represented below.

The indirect method consists in determining the cash flows starting from the Net Income for the period to which the income statement items that do not correspond to cash outlays, or depreciation, provisions and write-downs (plus any provisions for internal work), must be added. In the theoretical hypothesis that Customer Receivables, Supplier Payables and Inventories were all equal to zero, in this way the cash flows deriving from the characteristic management (or Cash Flow deriving from operational management) would be obtained. To take into account the financial resources absorbed by the working capital, the indirect method provides for the correction of the balance previously obtained with the so-called "equity delta", or:

  • (Increase) Decrease in Customer Credits
  • (Increase) Decrease in inventories
  • Increase (decrease) in payables to suppliers

Also adding up the equity deltas relating to Other Receivables and Other Payables the Operating Cash Flow is obtained.

By processing at least two consecutive annuities (necessary requirement for the calculation of the Cash Flow Statement) following the Indirect method, Leanus automatically calculates the Cash Flow Statement divided into its three main sections:
the Operating Activity or Operating Cash Flow, divided in such a way as to highlight the different impact of the Operating and Non-Operating Working capital;
Cash Flow Investment Activities (Divestment): algebraically obtained the increase or decrease in the Net Fixed Assets net of depreciation and increases in fixed assets for internal work;
Cash Flow Financing Activities: In this section, where the positive and negative movements of Financial Debts and Shareholders' Equity are represented, it is possible to understand the movements of cash between the company and the financial system and between the company and the property.

The sum of the three sections, allows to obtain the Net Cash Change. The initial cash present in the balance sheet at the beginning of the period added to the Net Cash change must necessarily provide the value of the cash present in the balance sheet at the end of the period.

The cash flow analysis makes it possible to highlight any forcing interventions carried out on the accounting data.

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The budget ratios

The reclassification of the financial statements or an accounting situation using the proposed formats, it allows to elaborate the main financial statement ratios. In case you need to carry out the comparison (or benchmark) between different subjects, it is necessary to link the respective accounting schedules to the same reclassification model. Thus the comparison by indices will be able to highlight the real differences. In Leanus the main financial statement ratios and related descriptions are present:

  • Growth
  • Efficiency
  • Profitability
  • Solidity and Liquidity

Il Training Program it includes sessions dedicated to the interpretation of the individual financial statement ratios.

Download here the complete index of the Leanus manual

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